Stocks Fall as Data Fuel Debate on Fed’s Next Move: Markets Wrap

(Bloomberg) — Stocks fell after data showed hotter-than-expected inflation and a slowdown in the labor market, amplifying the debate on whether the Federal Reserve will opt for a smaller rate cut next month or a pause after a large September reduction.

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Following a rally to all-time highs, the S&P 500 took a breather. While Thursday’s economic figures were not perceived by Wall Street as catastrophic, they certainly highlighted the Fed’s challenge of bringing inflation back to the 2% target without cooling the jobs market too much. And that has added to the debate about the Fed’s next steps. For now, bond traders continued to bet the central bank will reduce the pace of cuts to 25 basis points in November.

Three Fed policymakers — John Williams, Austan Goolsbee and Thomas Barkin were unfazed by a higher-than-forecast consumer price index, suggesting officials can continue lowering rates. The outlier was Raphael Bostic of the Atlanta Fed. In an interview with the Wall Street Journal he revealed that, in projections released in September, he had called for one additional quarter-point cut this year. The Fed has two remaining meetings in 2024.

“One slightly hotter-than-expected CPI reading doesn’t mean a new wave of inflation has been unleashed, but the fact that it accompanied a jump in weekly jobless claims may add to short-term market uncertainty,” said Chris Larkin at E*Trade from Morgan Stanley. “These weren’t good numbers — but that doesn’t mean they upended the larger outlook for solid economic growth and moderate inflation.”

In a note titled “The Fed’s quandary as inflation warmer while labor cooler,” Quincy Krosby at LPL Financial says the latest economic numbers were not the combination the Fed wants to see.

“If inflation data continues to indicate that prices are generally rising amid a backdrop of a cooler labor market, the Fed’s next meeting will undoubtedly involve a more heated discussion of which of the Fed’s mandates takes precedence,” she noted.

The S&P 500 fell 0.2%. Most major groups retreated, though energy shares joined oil higher as the market awaited Israel’s response to Iran’s missile attack. Megacaps were mixed, with Nvidia Corp. up and Apple Inc. down. Tesla Inc. edged lower ahead of the launch of the company’s fully self-driving vehicle.

The yield on 10-year Treasuries was little changed at 4.07%. The Bloomberg Dollar Spot Index wavered.

Wall Street’s Reaction:

Today’s CPI report will lower enthusiasm around rate cuts next month, and if some of these other catalysts increase uncertainty, it could act as a short-term excuse for markets to pull back — particularly with the S&P 500 at all-time highs.

The Fed said the last mile getting toward their inflation target is going to be tough, and that is what we are seeing. But we still expect the Fed to cut rates by a quarter point in November, and likely a similar cut at the December meeting.

If anything, the report was good enough to solidify the case for another quarter-point cut. Inflation hasn’t receded so rapidly to justify an accelerated pace of policy easing, but the upside surprise also wasn’t sufficient to raise serious questions about the underlying disinflationary trend.

The Federal Reserve isn’t yet in position to declare ‘mission accomplished’ in the battle against inflation, and the ride to the 2% target continues to be bumpy at times.

Mindful of its dual mandate prioritizing maximum employment and stable prices, it will be eager to see the next monthly jobs report in early November before the next announcement on rates. A safe bet for now is rate reductions of one-quarter of 1% at the final two meetings of the year.

The CPI surprised to the upside in September, rising faster than the consensus expectation in both the headline index and the core. The core increase wasn’t hot enough to rule out a November rate cut, however.

The Fed has shown that they’re willing to let inflation potentially run hotter than normal in favor of full employment. Only a rise towards 4% inflation or a few hot inflation prints in a row would alter the Fed’s course of continued rate cuts over the next year.

Given that the most recent jobs report was so strong, it was possible that a big upside surprise to inflation could have caused the Fed to pause at the next meeting and leave rates unchanged.

However, given that this month’s report was a little higher than expected it is still likely that the Fed will go ahead and cut by 25 bps next month and – if nothing in the labor market or inflation readings materially changes by the end of the year – another 25 bps in December.

The market reacted negatively to recent indications from policymakers that the next cut would be 0.25%, however, history tells us that consecutive dramatic rate cuts tend to come about when the economy is in distress, so while we expect a cut next month, investors may be wise to hope for a gradual drop.

Corporate Highlights:

Delta Air Lines Inc. forecast profit and sales short of Wall Street’s estimates for the final months of the year, suggesting a slow recovery from a challenging summer travel season.
Domino’s Pizza Inc. trimmed its 2024 projection for sales growth and new locations as slower consumer spending hits the restaurant industry.
Pfizer Inc. company officials threatened legal action against two former top executives who had been working with Starboard Value to push for changes at the drugmaker, the activist investor alleged Thursday in a letter to the company’s board.
GXO Logistics Inc., the supply-chain services provider that spun off from trucking company XPO Inc. in 2021, is exploring a sale, according to people familiar with the matter.
Eli Lilly & Co. is ramping up its legal campaign against companies that were temporarily allowed to make and sell copycat versions of its blockbuster drugs used for weight loss until a US shortage ended last week.
Toronto-Dominion Bank will pay almost $3.1 billion in fines and other penalties and face a cap on its US retail banking assets, after pleading guilty to failing to prevent money laundering by drug cartels and other criminals.

Key events this week:

JPMorgan, Wells Fargo kick off earnings season for the big Wall Street banks, Friday
US PPI, University of Michigan consumer sentiment, Friday
Fed’s Lorie Logan, Austan Goolsbee and Michelle Bowman speak, Friday

Some of the main moves in markets:

Stocks